Beyond the numbers: Tax haven issues outside the tax gap

Building on this write-up from last week (in Danish) on the issues posed by tax havens for Denmark, I wanted to put the main points up in English as well, as I feel they are pertinent to the wider debate on tax havens, tax evasion and so forth ongoing right now.

The question that always pops up in these debates is: How big is the problem for us? Now, if you look purely at the economic question of tax lost (the tax gap) from tax evasion in tax havens, the correct answer is: We don’t really know. Due to the nature of the activity in question, it is difficult to impossible to estimate with any precision the assets located ‘offshore’/in tax havens and the tax lost ‘onshore’. As the PanamaPapers show, tax havens and offshore tax constructions are fundamentally about secrecy. That is one reason we keep seeing examples of corrupt politicians and criminals involved in these schemes – they wanted to hide activites from sunlight. Secrecy obscures our ability to view the activities in tax havens, and this is made even more difficult by the breadth and depth of the issue. Tax evasion and associated activities using tax havens and offshore vehicles is very complex; there are many different techniques and schemes, used by many different actors, each of which is difficult to map. There are blind spots everywhere.

So we can’t really say exactly how much money is lost. The estimates available are all, more or less, based on insufficient data. That said, there is certainly good work on the topic. Probably the most recognised estimate is from Gabriel Zucman, who has argued that offshore wealth amounts to $5.9tr (roughly 8% of the gross world product). Zucman estimates that at least two-thirds (and probably more) of these funds are unregistrered, and that at least 3% of the unregistered funds are lost through tax evasion. This gives a total world tax gap from offshore wealth of at least $120bn/year (Zucman’s own “best guess” is around $190bn). And then we have work from OECD and IMF on the tax gap from base erosion and profit shifting (BEPS) – which is of course not quite the same, but which may be part of the same issue – which also run in the triple-digit billion dollars a year. Of course, we shouldn’t forget Richard Murphy’s controversial and widely cited $1tr tax lost estimate for the European Union countries.

The key point I want to bring up here is: We don’t know. There may be indications that the numbers are big, but essentially the knowledge we have on this topic is insufficient.

So why should we care about this whole tax haven issue? We don’t even know how much money is being lost. Do we need to even talk about it?

And now we get to the main point of this post: Even if you ignore the purely economic tax gap perspective, there are good reasons to have a public and political discussion about the issue of tax havens and offshore tax evasion. In particular, I want to highlight sovereignty and democracy, fair competition, tax morale, mistrust and financial stability.

First and foremost, tax havens can be viewed as a threat to other countries’ sovereignty. When citizens and companies from Denmark (or Germany or England, etc.) utilize Panama/Delaware/Ireland to evade taxes, the former countries’ tax bases are decreased, reducing collectible tax, which can be seen as a significant influence on the political and economic abilities of those countries. The same effect can occur because countries are forced into a race to the bottom tax competition in order to attract investment and capital. Opinions are divided on tax competition, but it is clear that it places an important constraint on national Parliaments. And this also causes a democratic issue. Legislation in tax havens is designed so that individuals and businesses can circumvent or minimize the effect of laws and regulations elsewhere. In this sense, the ability of other national Parliaments to effectively legislate within their borders is impaired. This may be seen as a democratic problem because tax havens limit the ability of publicly elected officials to do their job and decide the make-up of policies and society, including who pays for what.

Another argument is that tax havens hurt fair competition. When certain companies and individuals have more opportunities to evade or avoid national tax and rules, or to a greater extent takes advantage of such opportunities, everyone else is disadvantaged. When only certain actors in a competitive market are able or willing to effectively use tax minimisation strategies (or circumvent other national legislation), there is a risk of distorted markets and un-level playing fields. We know, for instance, that multinational companies have more opportunities for tax planning than purely national companies. And we also know that Anglo-Saxon companies are more tax aggressive than, e.g., continental European firms. This can hurt certain economic actors directly, and it can hurt fair market competition in general, thereby creating suboptimal economic outcomes.

A third and related point on why the issue of tax havens might be a worthwhile political discussion is tax morale. In short, tax morale is a public’s willingness to pay the right amount of tax in accordance with the rules. It is essentially a measure of tax evasion in a society. If tax morale is high, tax evasion is low, and so is the tax gap. One important factor in determining a society’s tax moral is social influences. (I recommend Martin Hearson’s thorough blog on this topic.) If people are of the perception that other tax payers are cheating, or that the risk of getting caught while cheating is small, or that the system advantages certain people over others, the tax morale will drop. It is fair to wonder if revelations such as the PanamaPapers have this exact effect. And when the tax morale drops, tax evasion is likely to rise as a result, decreasing the tax base and tax collected, which in turn forces politicians to compensate by raising taxes, taxing more activities, or cut down on public services.

A fourth and, again, related argument concerns mistrust. Just like the PanamaPapers and similar leaks can reduce the tax morale in a society because the revelations expose unacceptable behaviour, tax haven activity can also reduce trust in politicians, firms and (groups of) individuals implicated. The public campaigns against onshore banks, tax advisers, politicians and sports stars that we have seen in the wake of the PanamaPapers are apt examples. Whether or not the accused parties have actually done anything illegal doesn’t matter – the reputational damage is substantial. But trust is essential for our economies and our democracies. Less trust in economic and political actors can help create economic and political imbalance. In short, tax haven activity (and revelations thereof) can be unnecessarily costly to our economies and democracies. It can also create lasting societal change (which may be viewed as good or bad). See, e.g., the rise of anti establishment parties around Europe after the financial crisis.

A fifth point is about financial stability. After the financial crisis, there has been broad agreement that tax havens played a significant role in the crisis. Offshore markets and tax havens were said to have contributed to massive shadow banking activity, which was a key factor in increasing the overall level of risk in the financial system. While the recent Panama leaks mostly show individuals’ tax evasion, it also gives us insights into the exact kind of secrecy, offered in Panama and elsewhere, which helps create financial instability. If we can reduce the size of this shadow economy, we might potentially create a more healthy financial system in the process.

In short, there is a number of reasons why you might – even if you look beyond the purely economic tax lost focus – demand a serious public and political discussion on tax havens and their material impact on other countries.

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2 comments

I agree with your point on secrecy and the fact that there is uncertainty about how much is illicitly hidden, and lost from public treasuries. But I don’t think we should get too carried away with how much we don’t know. For example we know that Richard Murphy’s 1 trillion Euro number is not right as an estimate of how much European governments lose to international tax havenry (avoidance and evasion), because he is clear that that is not what he was trying work out in this case (his number is based on an estimate of the size of the grey economy in each European country – i.e. including cash-in-hand business and simple domestic under-reporting rather than specifically focusing on stuff involving cross border financial structures).

I don’t think that most important stuff in the Panama Papers is about legal personal or corporate tax planning (i.e. the David Cameron’s Dad stuff that has captured so much attention).

But what seems to me the most important issue is not primarily about tax at all but about the use of anonymous shell companies as a getaway vehicle for corruption and theft of public assets (which may be only as small proportion of the overall activity, but matters)

Thanks for good reflections and another excellent blog of your own on the topic. I do agree on your comments regarding the numbers and estimates, which could be discussed at length. Here, I merely wanted to highlight the variety in estimates to argue that even though we have very little firm knowledge, and even though the numbers might only indicate a big problem, there are important reasons why political and public debates are needed.

As you refer in the blog, there is broad agreement (including myself) that the Panama Papers largely concern secrecy and, where tax is concerned, individual’s tax planning (some of which is likely to be tax evasion, even if this is cannot be readily proved), rather than tax avoidance or morality questions.